CHAPTER 24 PERFORMANCE MEASUREMENT AND RESPONSIBILITY ACCOUNTING*See additional information on next page that pertains to these quick studies, exercises and problems. SP refers to the Serial ProblemES refers to Excel SimulationsAdditional Information on Related Assignment MaterialConnectA vailable on the instructor’s course-specific website) repeats all numerical Quick Studies, all Exercises and Problems Set A. Connect also provides algorithmic versions for Quick Study, Exercises and Problems. It allows instructors to monitor, promote, and assess student learning. It can be used in practice, homework, or exam mode.Connect InsightThe first and only analytics tool of its kind, Connect Insight is a series of visual data displays that are each framed by an intuitive question and provide at-a-glance information regarding how an instructor’s class is performing. Connect Insight is available through Connect titles.The Serial Problem (SP) for Success Systems continues in this chapter.General LedgerAssignable within Connect, General Ledger (GL) problems offer students the ability to see how transactions post from the general journal all the way through the financial statements. Critical thinking and analysis components are added to each GL problem to ensure understanding of the entire process. GL problems are auto-graded and provide instant feedback to the student.Excel SimulationsAssignable within Connect, Excel Simulations allow students to practice their Excel skills—such as basic formulas and formatting—within the context of accounting. These questions feature animated, narrated Help and Show Me tutorials (when enabled). Excel Simulations are auto-graded and provide instant feedback to the student. Synopsis of Chapter RevisionsNEW opener—Ministry of Supply and entrepreneurial assignment.Reorganized chapter.Revised discussion of performance evaluation and decentralization.Revised discussion of Kraft Heinz responsibility centers.Revised exhibit on responsibility accounting.Revised discussion of responsibility accounting reports.Added NTKs on responsibility accounting, cost allocations, and balanced scorecard.Revised discussion of indirect expense allocations.New exhibit and discussion of general model of expense allocation.New exhibit on common allocation bases for indirect expenses.Revised discussion of preparing departmental income.New exhibit and formula for computing departmental income.Added short section on transfer pricing to the chapter.New Sustainability section with discussion of General Mills, Target and performance reporting, and Ministry of Supply example.Chapter OutlineNotes I.Responsibility AccountingA. Performance Evaluationrge companies are easier to manage if divided into smallerunits called divisions, segments, or departments.2.In decentralized organizations, decisions are made by unitmanagers rather than top management.3.In responsibility accounting, unit managers are evaluated onlyon what they are responsible for.4.The methods of performance evaluation vary for cost centers,profit centers and investment centers.a.Cost center−incurs cost or expenses without directlygenerating revenues (e.g. manufacturing department andservice department).b.Profit center−incurs costs and generates revenues (e.g.product centers).c.Investment center−incurs costs, generates revenues and isresponsible for effectively using center assets.5.Basis for evaluating performance:a.Cost center managers are evaluated on their success incontrolling costs compared to budgeted costs. Profit center:ability to generate more revenue than expenses.b.Profit center managers are evaluated on their success ingenerating income.c.Investment center managers are evaluated on their use ofinvestment-center assets to generate income.II.Controllable versus Uncontrollable CostsA.Controllable Costs -1.Those which a manager has the power to determine or at leastsignificantly affect the amount incurred.B. Uncontrollable costs –1.Are not within the manager’s control.2. A manager’s performance is evaluated using responsibilityreports that describe the department’s activities in terms ofcontrollable costs3.Distinguishing between controllable and uncontrollable costsdepends on the particular manager and the time period underanalysis.4.All costs are controllable at some level of management if the timeperiod is sufficiently long;5.Good judgment is required when identifying controllable costs.Chapter OutlineNotesC.Responsibility Accounting Performance Report1.Reports actual expenses that a manager is responsible for andtheir budgeted amounts.a.Management’s analysis of differences between actual andbudget often results in corrective actions.ed by upper management to evaluate effectiveness oflower-level managers in controlling costs.c.Recognizes that control over costs and expenses belongs toseveral layers of management.2.Responsibility Accounting Reporta.Provide relevant information for each management level.b.At lower levels, managers have limited responsibilities andtherefore fewer controllable costs.c.Responsibility and control broaden for higher-levelmanagers.III.Profit CentersA.The responsibility report focuses on how well each departmentcontrolled costs and generated revenues.B.The departmental income statement is a common way to reportprofit center performance.C.When computing department profits, two key accounting challengesinvolve allocating expenses:1.How to allocate indirect expenses, such as rent and utilities whichbenefit several departments.2.How to allocate service department expenses, such as payroll orpurchasing, that perform services that benefit severaldepartments.D.Direct and Indirect Expenses1.Direct Expenses are readily traced to a department.a.Incurred for sole benefit of that one department; no allocationrequired.b.Often, but not always, controllable costs.2.Indirect Expenses are incurred for joint benefit of more than onedepartment; can’t be readily traced to just one department.a.Allocated across departments benefiting from them.b.Ideally allocated using a cause-effect relation or, if cause-effect relation cannot be identified, allocated on a basisapproximating the benefit received by each department.c.Typically considered uncontrollable costs.Chapter OutlineNotesE.General Model – indirect and service department expenses areallocated across departments benefiting from them. Allocated using acause-effect relation. Sometimes hard to identify.1.Allocated Cost = Total Cost to Allocate x Percentage ofAllocation Base Used.F.Allocating Indirect Expenses – allocation bases vary acrossdepartments and organizations. Managers must use careful judgmentin developing allocation bases. Commonly used allocation bases:1.Wages and salaries –allocated using relative amount of hoursworked in each department.2.Rent and Utilities allocated based on portion of floor spaceoccupied. More valuable location may charge department higherrate.3.Advertising – allocated using a percentage of total sales.4.Depreciation – allocated using hours of depreciable asset used.G.Service Department expenses –provide support to an organization’soperating departments. Common allocation bases:1.Office, personnel, and payroll expenses – allocated based onnumber of employees in each department.2.Purchasing costs – allocated based on dollar amount of purchasesor number of purchase orders processed.3.Maintenance expenses – allocated based on square footage.H.Departmental Income Statements1.Departmental income is computed using the following formula:Departmental income = Dept. sales – Dept. direct expenses –Allocated indirect expenses – Allocated service dept. expenses.2.Four Steps for allocating costs and preparing departmentalincome statements:a.Step one – accumulate revenues and direct and indirectexpenses by department. Involves collecting the necessarydata from general company and departmental accounts.i.Direct and indirect expenses include salaries, depreciationand supplies expenses.b.Step two – allocate indirect expenses across both service andoperating departments.i. Uses a departmental expense allocation spreadsheetshown in Exhibit 24.10.ii.After selecting allocation bases, indirect expenses arerecorded in company accounts and allocated to bothoperating and service departments.Chapter OutlineNotesc.Step three – allocate service department expenses tooperating departments using a departmental expenseallocation spreadsheet. After service department costs areallocated, no expenses remain in the service departments.d.Step four – prepare departmental income statements using thedepartmental expense allocation spreadsheet.i. Actual service department expenses are compared withbudgeted amounts to help assess cost center performance.ii.Amounts in the operating department columns are used toprepare departmental income statements. (Exhibit 24.15)I.Departmental Contribution to Overhead (see Exhibit 24.12)1.Departmental income statements not always best for evaluatingeach profit center’s performance especially when indirectexpenses are a large portion of total expenses.2.Evaluate using departmental contributions to overhead a reportof the amount of sales less direct expenses.3.Behavioral Aspects of Departmental Performance Reports –a.Indirect expenses are typically uncontrollable, so a better wayto evaluate is using departmental contribution to overhead.b.Including indirect expenses in department manager’sperformance evaluation can lead to the manager being morecareful in using service departments.c.Some companies allocate budgeted service department costsso operating departments are not held responsible forexcessive costs from service departments.IV.Investment CenterA.Financial Performance Evaluation Measures include:1.Return on investment, return on assets, computed as investmentcenter income / by investment center average invested assets.2.Residual income – Expressed in dollars. Encourages divisionmanagers to accept all opportunities that return more than targetincome. Computed as investment center income – targetinvestment center income.3.Profit margin and investment turnover – split return oninvestment into two measures – profit margin and investmentturnover.a.Profit margin measures income earned per dollar of salescomputed as investment center income divided by investmentcenter sales. Usually use income before tax. Expressed as apercent.b.Investment turnover measures how efficiently an investmentcenter generates sales from its invested assets. Calculated asinvestment center sales divided by investment center averageassets. Expressed as the number of times assets wereconverted into sales.Chapter OutlineNotes4.Nonfinancial Performance Evaluation Measures –using solelyfinancial measures has limitations. Companies can considernonfinancial measures to help in evaluating division manager’sperformance.5.Balanced Scorecard: system of performance measures,including nonfinancial measures used to assess company anddivision manager performance. Requires managers to think oftheir company from four perspectives.a.Customer: what do they think of us?b.Internal process: which of our operations are critical?c.Innovation and learning: how can we improve?d.Financial: what do our owners think of us?V.Decision Analysis Cycle Time and Cycle EfficiencyA.As lean manufacturing practices help companies move toward justin time manufacturing it is important for companies to reduce thetime it takes to manufacture its products and improve efficiency.1.Cycle time measures the time element which describes the timeit takes to produce a product or service.Cycle time = Process + Inspection + Move + WaitTime Time Time Timea.Process time is considered value-added time – it is the onlyactivity in cycle time that adds value to the product from thecustomer’s perspective. The other three activities areconsidered non-value-added time: they add no value to thecustomer.2.Cycle Efficiency measures production efficiency. It is the ratioof value added time to total cycle time.Cycle Efficiency = Value added timecycle timea.If the cycle efficiency is low, the company should evaluatethe production process to see if it can identify ways toreduce the non-value added activities.VI.Appendix 24A – Cost Allocations uses the general model of costallocation to show how the cost allocations in Exhibits 24.10 and 24.11for A-1 Hardware. Rent expense, utilities expense, advertising expenseand insurance expense are allocated first. Then, the two servicedepartment’s expenses are allocated to the three operating departments.Chapter OutlineNotes VII.Appendix 24B – Transfer PricingThe price used to record transfers between divisions in the samecompany is called a transfer price. Can be used in cost, profit andinvestment centers.A.If there is no excess capacity, the internal supplier will not accept atransfer price less than the market price. This is called market basedtransfer pricing.B.If there is excess capacity, the internal supplier should accept a pricebetween the costs to manufacturer the part and the market price.This is called cost based transfer pricing.C.Other issues to consider in determining transfer prices include:1.Market price may not exist2.Cost controls3.Division managers’ negotiation4.Nonfinancial factors to consider include: quality control,reduced lead times and impact on employee morale.III.Appendix 24C – Joint CostsA.Joint Costs−the costs incurred to produce or purchase two or moreproducts at the same time; similar to indirect expense in that it’sshared across more than one cost object.1.Ignored when deciding to sell product as is or process further.2.Allocated to different products produced from it when total costof each product must be estimated (e.g., preparation of GAAPfinancial statements).3.Allocation basesa.Physical basis−allocates joint costs using physicalcharacteristics such as ratio of pounds, cubic feet or gallonsof each joint product to the total pounds, cubic feet orgallons of all joint products flowing from the cost; does notreflect the extra value flowing into some products or theinferior value flowing into others. Not the preferred method.b.Value basis−allocates joint cost in proportion to the salesvalue of the output produced by the process at the “split-offpoint”.Chapter 24 Alternate Demo ProblemJack and Susan Roberts own a farm that produces potatoes. Based on a review of the income statement shown below, Jack remarked that they should have fed the No. 3 potatoes to the pigs; then they would have avoided the loss from the sale of the those potatoes.JACK AND SUSAN ROBERTSIncome from the Production and Sale of PotatoesFor Year Ended December 31, 20xxResults by GradeSales by grades:No. 1, 300,000 lbs. $0.045 per lb.No. 2, 500,000 lbs. $0.04 per lb.No. 3, 200,000 lbs. $0.03 per lb.CombinedCosts:Land preparation, seed,planting,cultivating @ $0.01422 per lb.Harvesting, sorting, grading@ $0.01185 per lb.Marketing @ $0.00415 per lb.Total costsNet income (or loss)Jack and Susan divided their costs among the grades on a per pound basis, because their records do not show cost per grade. However, their records did show that $4,020 of the $4,150 of marketing costs represented the cost of placing the No. 1 and No. 2 potatoes in bags and hauling them to the warehouse of the produce buyer. Bagging and hauling costs were the same for both grades. The remaining $130 represented the cost of loading the No.3 potatoes into the trucks of the potato starch factory that bought these potatoes in bulk and picked them up at the farm.Required:Prepare an income statement that will better show the results of producing and marketing the each of the grades of potatoes.Chapter 24 Alternate Demo Problem: SolutionJACK AND SUSAN ROBERTSIncome from the Production and Sale of PotatoesFor Year Ended December 31, 20xxRevenue from sales:Costs:Land preparation, seed,planting, cultivatingHarvesting, sorting, gradingMarketingTotal costsNet incomeCOST ALLOCATIONSLand preparation, seed, planting, andcultivating:No. 1: $13,500 / $39,500 x $14,220 = No. 2: $20,000 / $39,500 x $14,220 = No. 3: $ 6,000 / $39,500 x $14,220 = $ 4,8607,2002,160 $14,220Harvesting, sorting, and grading:No. 1: $13,500 / $39,500 x $11,850 = No. 2: $20,000 / $39,500 x $11,850 = No. 3: $ 6,000 / $39,500 x $11,850 = $ 4,0506,0001,800 $11,850Marketing:No. 1: $13,500 / $33,500 x $4,020 = No. 2: $20,000 / $33,500 x $4,020 = $1,620 2,400Subtotal bagging and hauling costs 4,020 No. 3: Loading costs 130$4,150。
